Chapter 11 Stockholders’ Equity PowerPoint Authors: Brandy Mackintosh

Chapter 11 Stockholders’ Equity PowerPoint Authors: Brandy Mackintosh
Lindsay Heiser Chapter 11: Stockholders’ Equity

Explain the role of stock in financing a corporation
Learning Objective 11-1 Explain the role of stock in financing a corporation Learning objective number 11-1 is to explain the role of stock in financing a corporation.

Corporate Ownership The major advantage of the corporate form of business is the ease of raising capital as both large and small investors can participate in corporate ownership. Simple to become an owner Easy to transfer ownership Provides limited liability Part I The corporate form of organization has several advantages. The major advantage is the ease of raising large amounts of money because both large and small investors can participate in corporate ownership. It is simple to become an owner of corporate shares of stock and it is just as simple to sell the shares. Organized exchanges, such as the New York Stock Exchange, maintain markets in which shares in thousands of companies are bought and sold each business day. Stockholders’ losses are limited to the amount invested in the corporation. Corporate creditors cannot make claims on the personal assets of shareholders to satisfy corporate debt. Part II Corporations are entities created by law that exist separately from their owners and that have rights and privileges. As separate entities, corporations can: Own assets. Incur liabilities. Sue and be sued. Enter into contracts. Stockholders are not agents of the corporation and cannot enter into contracts on the corporation’s behalf. Because a corporation is a separate legal entity, it can Own assets. Incur liabilities. Sue and be sued. Enter into contracts.

Corporate Ownership Voting rights. Dividends. Residual claims.
Stockholder Benefits Dividends. Residual claims. Part I In addition to voting on important issues at annual meetings, stockholders have other benefits. Part II Stockholders have the right to receive dividends when declared by the board of directors. Part III In the event of liquidation, stockholders share, according to their percentage ownership, in any remaining assets after creditors are paid. Part IV Existing shareholders may be given the first chance to buy newly issued shares of stock before it is offered to others. Preemptive rights.

Corporate Ownership Ultimate control of a corporation rests with the stockholders. At their annual meeting, stockholders elect the Board of Directors and vote on important management issues facing the company. The members of the board of directors hire the executive officers of the corporation. Finally, officers of the corporation empower others to hire needed employees.

Equity Versus Debt Financing
Advantages of equity and debt financing. Advantages of equity Equity does not have to be repaid. Dividends are optional. Advantages of debt Interest on debt is tax deductible. Debt does not change stockholder control. Part I Equity financing has some advantages when compared to debt financing. First, equity financing does not have to be repaid as does debt. Second cash dividends to stockholders are optional, whereas interest payments on debt are mandatory. Part II However, debt financing also has some advantages. First, interest payments to creditors are tax deductible, but dividend payments to stockholders are not. Second, selling additional shares of stock can dilute the ownership percentage of current stockholders, but additional debt does not change stockholder control.

Explain and analyze common stock transactions.
Learning Objective 11-2 Explain and analyze common stock transactions. Learning objective number 11-2 is to explain and analyze common stock transactions.

Common Stock Transactions
Stockholders’ Equity Contributed Capital Retained Earnings Treasury Stock Accumulated Other Comprehensive Income Part I A company’s Stockholders’ Equity section of the its balance sheet can include multiple items. Part II Contributed Capital reports the amount of capital the company received from investors’ contributions, in exchange for the company’s stock. For this reason, contributed capital represents paid-in capital. Part III Retained Earnings reports the cumulative amount of net income earned by the company less the cumulative amount of dividends declared since the corporation was first organized. Retained Earnings represents earned capital. Part IV Treasury Stock reports shares that were previously owned by stockholders but have been reacquired and are now held by the corporation. To fully understand treasury stock, it’s helpful to follow stock transactions through from authorization to issuance and repurchase, as we do in the following slide. Part V Accumulated Other Comprehensive Income reports unrealized gains and losses, which are temporary changes in the value of certain assets and liabilities the company holds. They can relate to pensions, foreign currencies, and financial investments, such as National Beverage’s contracts to stabilize the cost of its aluminum cans.

Authorization, Issuance, and Repurchase of Stock
Authorized Shares Outstanding shares are issued shares that are owned by stockholders. Issued shares are authorized shares of stock that have been distributed to stockholders. Unissued shares of stock are shares that have never been distributed to stockholders. Unissued Shares Treasury Outstanding The maximum number of shares of capital stock that can be issued to the public. Issued Shares Part I There are several terms related to stock that we need to understand. Authorized shares are the maximum number of shares of stock that can be issued to the public. The number of authorized shares is identified in the corporate charter of the corporation that is issued by the state. Part II Authorized shares can be classified as either issued or unissued. Issued shares are authorized shares of stock that have been distributed to stockholders. Unissued shares are authorized shares of stock that have never been issued to stockholders. Part III Issued shares can be classified as either outstanding shares or treasury shares. Part IV Outstanding shares are shares that are currently owned by stockholders. Part V Treasury shares are shares that were once owned by stockholders but the corporation repurchased the shares in the stock market. Now, the corporation is the owner of those shares. Treasury shares are issued shares that have been reacquired by the corporation.

Authorization, Issuance, and Repurchase of Stock
Here you see an example of the Stockholders’ Equity portion of National Beverage Corporation’s Balance Sheet. The three accounts, Common Stock, Additional Paid-in Capital, and Retained Earnings, are shown. Preferred Stock is a category of stock with special rights that we will discuss later. Notice the amount of detail disclosed for the Common Stock account. Par value is one cent per share. It is not unusual for par values to be as low as one cent per share. We will discuss the concept of par value later. The corporate charter authorizes a total of 75,000,000 shares of stock that can be issued, 50,300,000 of which have been issued. Of those shares issued, shares costing $18,000,000 have been reacquired by the company and are shown as treasury stock.

Par value is typically a very nominal amount such a $0.01 per share.
Stock Authorization Par value is typically a very nominal amount such a $0.01 per share. Par value is an arbitrary amount assigned to each share of stock when it is authorized. Market price is the amount that each share of stock will sell for in the market.  Part I Common stock normally has a par value which is usually a very small amount, such as one cent per share. Part II Par value is an arbitrary amount assigned to each share of stock in the corporate charter. Par value is not related in any manner to market value which is the selling price of a share of stock.

Some states do not require a par value to be stated in the charter.
Stock Authorization Some states do not require a par value to be stated in the charter. No-par Stock In addition to par value stock, some states permit no-par value common stock.

Stock Issuance Initial public offering (IPO)
The first time a corporation issues stock to the public. Seasoned new issue Subsequent issues of new stock to the public. Part I At the initial public offering, shares of stock are issued to the public for the first time, usually through major securities brokerage firms with retail offices in cities across the country. Part II At a later date, the company may wish to raise additional capital with another issue of stock to the public. This is referred to as a seasoned new issue. National Beverage issues stock.

Most issues of stock to the public are cash transactions.
Stock Issuance Most issues of stock to the public are cash transactions. National Beverage issued 100,000 shares of $0.01 par value common stock for $10 per share. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash +1,000,000 Common Stock ,000 Additional Paid-In Capital ,000 Part I When par value stock is issued for cash, the common stock account is credited for the par value of the stock sold. Remember that par value and market value are not related. The difference between the par value of the stock and the market value of the stock is credited to additional paid-in capital. Let’s record the entry for National Beverage Corp. for the issuance of 100,000 shares of one cent per share par value stock, sold for $10 per share in cash. Part II The transaction would affect the accounting equation by increasing assets (Cash) by $1,000,000 and increasing Stockholders’ Equity by $1,000,000 (Common Stock $1,000 and Additional Paid-in-Capital $999,000. Part III We debit Cash for the market value of the stock issued: 100,000 shares times $10 per share. Next, we credit Common Stock for the total par value of the shares issued: 100,000 shares times one cent per share. And last, we credit Additional Paid-in Capital for the excess of market value over par: $999,000. 2 Record dr Cash (+A) (100,000 x $10) cr Common Stock (+SE) (100,000 x $0.01) cr Additional Paid-In Capital (+SE) (1,000,000 – 1,000) 1,000 999,000 1,000,000

Stock Exchanged between Investors
Transactions between two investors do not affect the corporation’s accounting records. I’d like to buy 100 shares of National Beverage stock. I’d like to sell 100 shares of National Beverage stock. Once shares of stock are owned by the public, they may be bought and sold in the open market. Such transactions do not involve the company or its accounting records. The millions of shares that are bought and sold on the New York Stock exchange each business day are examples of this type of transaction.

Stock Used to Compensate Employees
Employees pay packages can include stock options Gives the employees the option to acquire company stock at a predetermined price Part I Stock can be used as a way to compensate employees and to encourage employees to work hard for a corporation Part II Employee pay packages often include a combination of base pay, cash bonuses, and stock options. Part III Stock options give employees the option of acquiring the company’s stock at a predetermined price, often equal to the then-current market price. Part IV If employees work hard and meet the corporation’s goals, the company’s stock price will increase. Part V Employees can then exercise their option to acquire the company’s stock at the lower predetermined price and sell it at the higher price for a profit. If the employees work hard and meet the corporation’s goals the stock price will increase. Employees can then exercise their option to acquire stock at the lower predetermined price and sell it at the higher price for a profit.

Repurchase of Stock A corporation repurchases its stock to:
Distribute excess cash to stockholders. Send a signal that the company believes its stock is worth acquiring. Obtain shares to reissue for the purchase of other companies. Obtain shares to reissue to employees as part of stock option plans. Corporations often buy their own stock back in the market. They do this because they want to distribute excess cash to stockholders, they believe the shares are worth acquiring, to increase their shares needed to use in the acquisition of another company, and to increase shares for use in employee stock option plans.

Repurchase of Stock National Beverage repurchases its own stock
(Treasury stock) Stockholders Employee Employee compensation package includes salary plus stock options. Stock options allow employees to purchase stock from the corporation at a fraction of the stock’s market price. Part I National Beverage repurchases its own shares from current stockholders. The repurchased shares are called treasury stock. Part II At a later date, National Beverage plans to use the treasury stock as part of an employee compensation plan. National Beverage grants options to employees. Part III Stock options will allow employees to purchase the shares of the company’s stock at a less than the stock’s market price.

No voting or dividend rights
Repurchase of Stock Treasury stock is not an asset. No voting or dividend rights Contra equity account Part I Dividends are not paid on treasury stock, and a corporation holding its own stock cannot vote using these shares at the annual meeting. Part II Treasury stock is not an asset. It is reported in the Stockholders’ Equity portion of the balance sheet as a reduction from total equity. Part III Treasury stock is usually recorded at the cost to purchase it, and the total cost of all shares of treasury stock held by the company is the amount reported as a reduction in Stockholders’ Equity. When stock is reacquired, the corporation records the treasury stock at cost.

Repurchase of Stock National Beverage reacquired 50,000 shares of its common stock at $25 per share. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash -1,250,000 Treasury Stock (+xSE) -1,250,000 Part I National Beverage purchased 50,000 of its own shares in the market for $25 per share, or $1,250,000. Part II The transaction would affect the accounting equation by decreasing assets (Cash) by $1,250,000 and decreasing Stockholders’ Equity (increasing Treasury Stock) by $1,250,000. Part III The entry includes a debit to Treasury Stock and a credit to Cash for $1,250,000, the amount of the purchase. The Treasury Stock would be reported on the Balance Sheet in the Stockholders’ Equity section as a reduction from total Stockholders’ Equity. 2 Record dr Treasury Stock (+xSE, -SE) cr Cash (-A) 1,250,000

Reissuance of Treasury Stock
National Beverage reissued 5,000 shares of the Treasury Stock at $28 per share. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash +140,000 Treasury Stock (-xSE) +125,000 Additional Paid-In Capital ,000 2 Record dr Cash (+A) (5,000 x $28) cr Treasury Stock (-xSE, +SE) (5,000 x $25) cr Additional Paid-In Capital (+SE) [5,000 x ($28 - $25)] 125,000 15,000 140,000 Part I Later, National Beverage reissued five 5,000 shares of the treasury stock for $28 per share. Remember that the original cost of the treasury stock was $25 per share. Part II The transaction would affect the accounting equation by increasing assets (Cash) by $140,000 and increasing Stockholders’ Equity by $140,000 (decreasing Treasury Stock by $125,000 and increasing Additional Paid-in-Capital by $15,000. Part III The entry would include a debit to Cash for $140,000, a credit to Treasury Stock for $125,000, and a credit to Additional Paid-in Capital for $15,000. The credit to Treasury Stock is the original cost of $25 per share times the 5,000 shares sold. The difference between the selling price and the cost of the Treasury Stock is credited to Additional Paid-in Capital. In this example that amount is $15,000. No profit or loss is recognized on treasury stock transactions. No profit or loss is recognized on treasury stock transactions.

Learning Objective 11-3 Explain and analyze cash dividends, stock dividends, and stock split transactions. Learning objective number 11-3 is to explain and analyze cash dividends, stock dividends, and stock split transactions.

Dividends on Common Stock
Declared by board of directors. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash. Cash dividends are declared by the board of directors. There is no legal obligation to declare a cash dividend, but once declared, there is a legal obligation to pay the dividend. Most corporations that pay cash dividends pay them quarterly. To pay a cash dividend, a corporation must have two things:  Sufficient retained earnings to absorb the dividend without going negative and  Enough cash to pay the dividend.

Dividends Dates There are three important dates to remember when discussing dividends:  The declaration date.  The date of record.  The date of payment. The date of declaration is the date the directors declare the dividend. At this time a liability is created and must be recorded. The date of record is important because it is the date when the corporation determines the owners of record who will receive the dividend. No entry is required in the accounting records on this date. The date of payment is the date the corporation pays the dividend to the stockholders who owned the stock on the record date.

Dividends Dates National Beverage declares an $2.30 dividend on each share of its 46,200,000 shares of common stock outstanding. 1 Analyze Liabilities Assets = Stockholders’ Equity + Dividends Payable ,260,000 Declared (+D) ,260,000 Part I National Beverage declares an $2.30 dividend on each of its 46,200,000 shares of common stock outstanding. Part II. The transaction would affect the accounting equation by increasing Liabilities (Dividends Payable) by $106,260,000 and decreasing Stockholders’ Equity by $106,260,000 (increasing Dividends Declared). Part III The entry at the date of declaration includes a debit to Dividends Declared and a credit to Dividends Payable for $106,260,000. Dividends Declared is a temporary account that is closed to Retained Earnings at the end of the year. 2 Record dr Dividends Declared (+D, -SE) cr Dividends Payable (+L) 106,260,000

Dividends Dates National Beverage paid the previously declared $2.30 dividend on its shares of common stock outstanding. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash -106,260,000 Dividends Payable ,260,000 Part I National Beverage paid the previously declared $2.30 dividend on its 46,200,000 shares of common stock outstanding. Part II The transaction would affect the accounting equation by decreasing Liabilities (Dividends Payable) by $106,260,000 and decreasing Assets (Cash) by $106,260,000. Part III The entry on the date of payment includes a debit to Dividends Payable and credit to Cash for $106,260,000, the total amount of cash paid to the owners of record. 2 Record dr Dividends Payable (-L) cr Cash (-A) 106,260,000

Distribution of additional shares of stock to stockholders.
Stock Dividends Distribution of additional shares of stock to stockholders. No change in total stockholders’ equity. All stockholders retain same percentage ownership. No change in par values. Part I A stock dividend is a distribution of additional shares of stock to stockholders. All stockholders retain the same percentage ownership. The stockholders have more shares of stock representing the same ownership as they had before the stock dividend. Part II There is no change in total stockholders’ equity. Part III Par value per share does not change. Part IV Corporations issue stock dividends to: Remind stockholders of the accumulating wealth in the company. Reduce the market price per share of stock to make the shares more affordable for investors to purchase. Signal that the management expects strong financial performance in the future. Corporations issue stock dividends to: Remind stockholders of the accumulating wealth in the company. Reduce the market price per share of stock. Signal that the company expects strong financial performance in the future.

Record at current market value of stock. Record at par value of stock.
Stock Dividends Small Large Stock dividend < 20 – 25% Stock dividend > 20 – 25% Record at current market value of stock. Record at par value of stock. Part I A stock dividend can be classified as small or large. A small stock dividend is a distribution of stock that is less than percent of the outstanding shares. Small stock dividends are recorded at the market value of the stock. Part II A large stock dividend is a distribution of stock that is greater than percent of the outstanding shares. Large stock dividends are recorded at the par value of the stock. Let’s look at the entry to record a large stock dividend. The journal entry moves an amount from Retained Earnings to other equity accounts.

Stock Dividends National Beverage issued a 20 percent stock dividend on 38,000,000 outstanding shares of its $0.01 par value common stock and accounted for it as a large stock dividend. 1 Analyze Liabilities Assets = Stockholders’ Equity + Retained Earnings -76,000 Common Stock ,000 Part I National Beverage issued a 20 percent stock dividend on 38,000,000 outstanding shares of its $0.01 par value common stock and accounted for it as a large stock dividend. Part II The transaction would affect the accounting equation by decreasing Retained Earnings by $76,000 and increasing Common Stock by $76, there is no change in total Stockholders’ Equity. Part III National Beverage would debit Retained Earnings and credit Common Stock for the number of shares issued times the par value of the stock. Twenty percent of 38,000,000 shares is 7,600,000 shares, so 7,600,000 shares times the $0.01 par value per share is $76,000. 2 Record dr Retained Earnings (-SE) cr Common Stock (+SE) 76,000

A stock split creates more pieces of the same pie.
Stock Splits An increase in the number of shares and a corresponding decrease in par value per share. Retained earnings is not affected. A stock split creates more pieces of the same pie. Assume that a corporation had 1,000,000 shares of $0.01 par value common stock outstanding before a 2–for–1 stock split. Part I Stock splits are not dividends. While they are similar to a stock dividend, they are quite different in terms of how they occur and how they affect the stockholders’ equity accounts. In a stock split , the total number of authorized shares is increased by a specified amount, such as 2-for-1. In this instance, each issued share is called in and two new shares are issued in its place. Cash is not affected when the company splits its stock, so the total resources of the company do not change. It’s just like taking a four-piece pizza and cutting each piece into two smaller pieces. Part II Before the two-for-one split, this company had 1,000,000 shares of $0.01 per share par value stock outstanding. Part III After the two-for-one split, the number of shares doubled and the par value was cut in half. Notice that an accounting entry is not required, and that retained earnings is not reduced. In many respects a 100 percent stock dividend and a two-for-one stock split result in similar impacts to the price per share in the stock market. The stock split usually requires more administrative tasks to call in and reissue stock certificates.

Comparison of Distributions to Stockholders
Part I Here you see the components of the Stockholders’ Equity section of a corporate Balance Sheet before showing the effects of a 2-for-1 stock split, a 100 percent stock dividend, and a $10,000 cash dividend. Part II The 2-for-1 stock split doubles the number of shares outstanding from 1,000,000 to 2,000,000 and reduces the par value per share from one cent to one-half cent, but has no effect on any of the account balances in Stockholders’ Equity. Part III The 100 percent stock dividend doubles the number of shares outstanding from 1,000,000 to 2,000,000, increases the Common Stock account from $10,000 to $20,000, and reduces Retained Earnings from $650,000 to $640,000. Part IV Notice that the cash dividend is the only distribution that decreases Total Stockholders’ Equity because it is the only one of the three that distributes the company’s resources to stockholders.

Learning Objective 11-4 Describe the characteristics of preferred stock and analyze transactions affecting preferred stock. Learning objective number 11-4 is to describe the characteristics of preferred stock and analyze transactions affecting preferred stock.

Preferred Stock Issuance
Priority over common stock Preferred Stock Usually has a fixed dividend rate Usually has no voting rights National Beverage issued 10,000 shares of its $1 par value preferred stock for $5 per share. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash +50,000 Preferred Stock ,000 Additional Paid-In Capital Preferred ,000 Part I Preferred stock is a separate class of stock that typically has priority over common stock in dividend distributions and distribution of assets in a liquidation, and is therefore less risky. Preferred stock usually has a stated dividend that is expressed as a percentage of its par value. Corporations may issue preferred stock to be able to raise needed capital without sacrificing control since preferred stock has no voting rights. Issuing preferred stock is a way to boost return to common stockholders. It is also a way to increase equity in the company if the common stock is perceived as too risky or has a lower than expected return. Part II National Beverage issued 10,000 shares of its $1 par value preferred stock for $5 per share. Part III The transaction would affect the accounting equation by increasing Assets (Cash) by $50,000 and increasing Stockholders’ Equity by $50,000 (Preferred Stock by $10,000 and Additional Paid-in Capital-Preferred by $40,000). Part IV To record the transaction, we debit Cash for the market value of the stock issued: 10,000 shares times $5 per share. Next, we credit Preferred Stock for the total par value of the shares sold: 10,000 shares times $1 per share. And last, we credit Additional Paid-in Capital-Preferred for the excess of market value over par: $40,000. 2 Record dr Cash (+A) (10,000 x $5) cr Preferred Stock (+SE) (10,000 x $1) cr Additional Paid-In Capital – Preferred (+SE) 10,000 40,000 50,000

Preferred Stock Dividends
Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock. Cumulative Dividend Preference: Any unpaid dividends from previous years (dividends in arrears) must be paid before common dividends are paid. Part I Preferred stock has a current dividend preference when compared to common stock. Current preferred dividends must be paid to preferred stockholders before any dividends are paid to common stockholders. Cumulative preferred stockholders have the right to be paid both the current and all prior periods’ unpaid dividends before any dividends are paid to common stockholders. When the preferred stock is cumulative and the directors do not declare a dividend to preferred stockholders, the unpaid dividend is called a dividend in arrears and must be disclosed in the financial statements. Part II Noncumulative preferred stock has no rights to prior periods’ dividends if they were not declared in those prior periods. If the preferred stock is noncumulative, any dividends not declared in previous years are lost permanently.

Assume the preferred stock of Flavoria carries only a current dividend preference and that the company declares dividends totaling $8,000 in 2012 and $10,000 in How much would the preferred and common stockholders receive in 2012 and 2013? Assume the preferred stock of Flavoria carries only a current dividend preference and that the company declares dividends totaling $8,000 in 2012 and $10,000 in How much would the preferred and common stockholders receive in 2012 and 2013?

In each year, a fixed amount of the total dividends would first go to the preferred stockholders, and only the excess would go to the common stockholders. So each year the preferred stockholders would receive $2,400 which is the 2,000 shares times the $20 par value times the 6% dividend rate. Had Flavoria Company not declared dividends in 2012, preferred stockholders would have had preference to $2,400 of dividends only in The current dividend preference does not carry over to later years unless the preferred stock is designated as cumulative, which is shown on the next slide.

Assume that Flavoria Company has the same amount of stock outstanding. However assume that dividends are in arrears for 2010 and How much would the preferred and common stockholders receive in 2012 and 2013? Assume that Flavoria Company has the same amount of stock outstanding. However assume that dividends are in arrears for 2010 and How much would the preferred and common stockholders receive in 2012 and 2013?

In 2012, dividends in arrears are satisfied first, followed by the current dividend preference, and the excess goes to common stockholders. So the preferred stockholders would receive $4,800 of dividends in arrears which is the same calculation as the last example but for 2 years instead of just 1. Then the preferred stockholders would also receive $2,400 for the current year’s dividend. The excess of $800 then goes to the common stockholders. In 2013, preferred dividends include only the current preference of that year because dividends in arrears were fulfilled in So therefore the preferred stockholders receive $2,400 for the current dividend with the remainder of $7,600 going to the common stockholders.

Retained Earnings Total cumulative amount of reported net income less any net losses and dividends declared since the company started operating. Baker Company Comparative Balance Sheets (Partial) For Year Ended December 31 Stockholders’ Equity Common Stock Additional Paid-in Capital Retained Earnings (Deficit) Total Stockholders’ Equity 2014 $ 100,000 750,000 50,000 900,000 2013 (70,000) 780,000 Part I Retained Earnings represents a corporation’s total earnings that have been retained in the business (rather than being distributed to stockholders). The balance in retained earnings increases each year that a company reports net income, and decreases each year that a company reports a net loss or declares cash or stock dividends. A negative balance in retained earnings is referred to as an Accumulated Deficit. Part II Baker Company incurred a loss of $120,000 in 2013 that resulted in an Accumulated Deficit in Retained Earnings. Baker Company incurred a loss of $120,000 in 2013 that resulted in an Accumulated Deficit in Retained Earnings.

Learning Objective 11-5 Analyze the earnings per share (EPS), return on equity (ROE), and price/earnings (P/E) ratios. Learning objective number 11-5 is to analyze the earnings per share (EPS), return on equity (ROE), and price/earnings (P/E) ratios.

Earnings Per Share (EPS)
Earnings per share is probably the single most widely watched financial ratio. Net Income Average Number of Common Shares Outstanding EPS = National Beverage’s income for 2011 was $40,800,000 and the average number of shares outstanding during the year was 46,200,000. Part I Earnings per share is one of the most widely used ratios. It is calculated by dividing Net Income by the average number of common shares outstanding. Part II National Beverage’s income for 2011 was $40,800,000 and the average number of shares outstanding during the year was 46,200,000. Part III National Beverage earned $0.88 for each share of common stock outstanding. Earnings per share is calculated by dividing Net Income of $40,800,000 by the 46,200,000 shares of Common Stock. $40,800,000 46,200,000 Shares EPS = = $0.88 per share

Return on Equity (ROE) Return on equity is the amount earned for each dollar invested by stockholders. Net Income Average Stockholders’ Equity ROE = National Beverage’s income for 2011 was $40,800,000 and the average Stockholders’ Equity was $110,950,000. Part I Another widely used financial ratio is return on equity, which tells us the amount earned for each dollar invested by stockholders. Return on equity is calculated by dividing Net Income by average Stockholders’ Equity. Part II National Beverage’s income for 2011 was $40,800,000 and the average Stockholder’s Equity was $110,950,000. Part III Return on equity for National Beverage is 38.6 percent, calculated by dividing net income of $40,800,000 by average stockholders’ equity of $110,950,000. Return on Equity tells us that National Beverage Corporation earned 36.8 cents for each dollar of its Stockholders’ Equity. $40,800,000 $110,950,000 ROE = = percent

Price/Earnings (P/E) Ratio
The P/E ratio is a measure of the value that investors place on a company’s common stock. Current Stock Price (per share) Earnings Per Share (annual) P/E = National Beverage’s stock price was $15.10 when the company reported its 2011 EPS of $0.88. Part I The P/E ratio is a measure of the value that investors place on a company’s common stock. It is calculated by dividing the current stock price per share by the annual earnings per share. Part II National Beverage’s stock price was $15.10 when the company reported its 2011 EPS of $0.88. Part III National Beverage Corporation’s P/E ratio is The P/E ratio tells us that investors are willing to pay 17.2 times the current year’s earnings for a share of National Beverage Corporation’s common stock. $ 15.10 $ 0.88 P/E = =

Comparison of EPS, ROE, and P/E Ratios
On your screen, you see a comparison of EPS, ROE, and P/E ratio for National Beverage Corporation and Pepsico. National Beverage Corporation’s higher ROE in 2011 arises because it has successfully used a strategy called financial leverage. Rather than rely on equity financing to expand its business, National Beverage Corporation relied on debt financing. National Beverage Corporation was able to generate more profit from using these borrowed funds than it incurred for interest on the debt. As a result, National Beverage Corporation generated a superior return on equity for stockholders.

Owners’ Equity for Other Forms of Business
Supplement 11A Owners’ Equity for Other Forms of Business Supplement 11A: Owners’ Equity for Other Forms of Business.

Owner’s Equity for a Sole Proprietorship
Only two owner’s equity accounts. A Capital account to record the owner’s investments and the periodic income or loss. A Withdrawal account to record the owner’s withdrawals of assets. A sole proprietorship has only two owner’s equity accounts. A Capital account to record the owner’s investments and the periodic income or loss. A Withdrawal account to record the owner’s withdrawals of assets. The Withdrawal account is closed to the capital account at the end of each period. No separate retained earnings account. Closed to the capital account at the end of each period.

Accounting for Owner’s Equity for a Sole Proprietorship
To record a $150,000 investment by H. Simpson, the owner. Part I H. Simpson invests $150,000 into his business. The investment is recorded by debiting Cash and crediting Capital for $150,000. Part II H. Simpson withdraws $1,000 per month from his business. The monthly withdrawal is recorded by debiting Drawings and crediting Cash for $1,000 each month. To record H. Simpson’s $1,000 monthly withdrawal.

Accounting for Owner’s Equity for a Sole Proprietorship
To close revenue and expense accounts to capital. Part I All revenue and expense accounts are closed to H. Simpson’s Capital account at the end of the accounting period. Part II H. Simpson’s Drawings account is closed to his Capital account at the end of the period by debiting Capital and crediting Drawings. To close the $1,000 monthly drawings to capital.

Accounting for Partnership Equity
Accounting for assets, liabilities, revenues and expenses follows the same accounting principles as any other form of business. Accounting for partners’ equity follows the same pattern as for a sole proprietorship. When a partnership is formed each partner may contribute both assets and liabilities to the partnership. Contributed assets increase partner’s capital and liabilities decrease partner’s capital. Assets are normally recorded at fair market value and liabilities are recorded at the amount payable. Each partner may be entitled to withdraw cash or other assets from the partnership. A withdrawal reduces the partner’s Capital account. Separate Capital and Drawings accounts are maintained for each partner.

To record investments by partners Able and Baker who will divide net income as follows: Able, 60 percent and Baker 40 percent. Part I Able and Baker form a partnership by investing $60,000 and $40,000 respectively. They will divide profits in the ratio of their initial investments. The investments are recorded by debiting Cash for $100,000 and crediting Able’s Capital account for $60,000 and crediting Baker’s Capital account for $40,000. Part II Able and Baker withdraw $1,000 and $650, respectively, each month. The monthly withdrawals are recorded by debiting Able’s Drawings account for $1,000, debiting Baker’s drawings account for $650, and crediting Cash for $1,650 each month. To record the partners’ monthly withdrawal.

To close revenue and expense accounts to partners’ capital. Part I All revenue and expense accounts are closed to the partners’ Capital accounts in the agreed upon ratio at the end of the accounting period. Able’s Capital account is credited for 60 percent of the $30,000 partnership profit, and Baker’s Capital account is credited for 40 percent of the $30,000 partnership profit. Part II The partners’ drawing accounts are closed to their Capital accounts at the end of the period by debiting Capital and crediting Drawings. To close the monthly drawings to partners’ capital.

Limited Liability Partnership (LLP) Limited Liability Company (LLC)
Other Business Forms Limited Liability Partnership (LLP) Protects innocent partners from malpractice or negligence claims. Most states hold all partners personally liable for partnership debts. Limited Liability Company (LLC) Owners have same limited liability feature as owners of a corporation. A limited liability company typically has a limited life. Partners may form a limited liability partnership, or LLP. An LLP protects innocent partners from malpractice or negligence claims brought against an offending partner. In most states individual partners are personally liable for the debts of the partnership. Partners may wish to consider forming a limited liability company, or LLC. In an LLC, individual owners have limited liability, but the company typically has a limited life defined in the agreement.

Chapter 11 Solved Exercises
M11-4, M11-8, E11-3, E11-6, E11-8, E11-11, E11-19 Chapter 11 Solved Exercises: M11-4, M11-8, E11-3, E11-6, E11-8, E11-11, E11-20

M11-4 Analyzing and Recording the Issuance of Common Stock
To expand operations, Aragon Consulting issued 1,000 shares of previously unissued common stock with a par value of $1. The price for the stock was $50 per share. Analyze the accounting equation effects and record the journal entry for the stock issuance. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash +50,000 Common Stock ,000 Additional Paid-In Capital ,000 Part I M11-4 Analyzing and Recording the Issuance of Common Stock To expand operations, Aragon Consulting issued 1,000 shares of previously unissued common stock with a par value of $1. The price for the stock was $50 per share. Analyze the accounting equation effects and record the journal entry for the stock issuance. Part II The asset account, Cash, will be increased by $50,000. The Stockholders’ Equity account Common Stock will be increased by $1,000 and the Stockholders’ Equity account Additional Paid-in Capital will be increased by $49,000. Part III We debit the asset account Cash for $50,000, we credit the Stockholders’ Equity accounts Common Stock for $1,000 and Additional Paid-in Capital for $49,000. 2 Record dr Cash (+A) cr Common Stock (+SE) cr Additional Paid-In Capital (+SE) 1,000 49,000 50,000

M11-4 Analyzing and Recording the Issuance of Common Stock
Would your answer be different if the par value were $2 per share? If, so, analyze the accounting equation effects and record the journal entry for the stock issuance with a par value of $2. The effects on total assets and total stockholders’ equity would not differ, but the amounts within the individual stockholders’ equity accounts would differ. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash +50,000 Common Stock +2,000 Additional Paid-In Capital ,000 Part I Would your answer be different if the par value were $2 per share? If, so, analyze the accounting equation effects and record the journal entry for the stock issuance with a par value of $2. Part II The effects on total assets and total stockholders’ equity would not differ, but the amounts within the individual stockholders’ equity accounts would differ. The asset account, Cash, will be increased by $50,000. The Stockholders’ Equity account Common Stock will be increased by $2,000 and the Stockholders’ Equity account Additional Paid-in Capital will be increased by $48,000. Part III We debit the asset account Cash for $50,000, we credit the Stockholders’ Equity accounts Common Stock for $2,000 and Additional Paid-in Capital for $48,000. 2 Record dr Cash (+A) cr Common Stock (+SE) cr Additional Paid-In Capital (+SE) 2,000 48,000 50,000

M11-8 Determining the Amount of a Dividend
Netpass Company has 300,000 shares of common stock authorized, 270,000 shares issued, and 100,000 shares of treasury stock. The company’s board of directors declares a dividend of $1 per share of common stock. What is the total amount of the dividend that will be paid? Dividends are paid on shares that are issued and outstanding. Dividends are not paid on treasury stock. Shares issued Less treasury stock Shares outstanding Dividend per share Total dividends paid 270,000 100,000 170,000 x $ $170,000 Part I M11-8 Determining the Amount of a Dividend Netpass Company has 300,000 shares of common stock authorized, 270,000 shares issued, and 100,000 shares of treasury stock. The company’s board of directors declares a dividend of $1 dollar per share of common stock. What is the total amount of the dividend that will be paid? Part II Dividends are paid on shares that are issued and outstanding. Dividends are not paid on treasury stock. Part III There are 170,000 shares outstanding (270,000 issued less 100,000 treasury shares). The total dividend paid is $170,000 (170,000 shares times $1.00 per share).

End of Chapter 11 End of chapter 11.

Chapter 11 Stockholders’ Equity PowerPoint Authors: Brandy Mackintosh

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Chapter 11 Stockholders’ Equity PowerPoint Authors: Brandy Mackintosh

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